Bitcoin isn’t a currency – and unless it becomes one it could be worthless

6 Dec 2017

Vili Lehdonvirta, University of Oxford

Bitcoin is in decline. Not its price, which has increased 900% this year and (at the time of writing) stands at over US$12,000 per unit, but its actual use as a currency. And this makes its rapid appreciation all the more puzzling.

A few years ago, enthusiasts triumphantly shared announcements from businesses that had started accepting Bitcoin. Over the last couple of years, such announcements have become scarce. Instead, businesses that once accepted the currency have begun to drop it.

The BBC contacted ten businesses in London that once advertised accepting Bitcoin. Four no longer accepted it, and two that did said they hardly ever received payments in Bitcoin. The same is even true online. The Wall Street Journal, citing a report by Morgan Stanley, recently reported that Bitcoin is now accepted by just three of the top 500 global online merchants, down from five last year.

If growing adoption as a currency can’t justify Bitcoin’s rapid appreciation, what can? Many enthusiasts have started to promote the idea of Bitcoin as a store of value. In economics, this is usually defined along the lines of “an item that people can use to transfer purchasing power from the present to the future”. In simple terms, it’s somewhere safe to invest your wealth that won’t lose its worth over time.

Apples can be used to barter services from a neighbour while they’re still fresh, but their purchasing power will disappear as they rot. The purchasing power can be retained into the future by exchanging the apples for money, gold, government bonds or some other store of value.

Some items have attributes that make them better stores of value than others, whether we are talking about physical items or digital objects. Gold is a good store of value because it’s durable. Electronic bond certificates are also durable as long as banks’ systems don’t fail, and have the added benefit of being easier to secure than physical valuables. Money, both physical currency and digital bank money, has the advantage of being very liquid, so it’s easy to convert into a purchase when needed.

Only one way to go from here?

Bitcoin does share many of these attributes of a good store of value. It also offers potentially high levels of financial privacy, somewhat similarly to the offshore banking system. This is an important attribute of a store of value for some people, although it also creates a lack of accountability and the potential for tax evasion.

But the most important attribute of a store of value is that it’s valuable. Gold is valuable because it has many industrial and decorative uses. Its price can fluctuate because of speculation on financial markets, but it can never fall to zero. There will always be someone willing to accept gold because it’s a useful commodity.

Similarly, US government bonds are ultimately valuable because they entitle the owner to a relatively secure flow of interest payments. Dollars and euros are valuable because they are widely accepted as a means of payment, and will continue to be so in the foreseeable future. In contrast, the future acceptability of the Venezuelan bolivar is in doubt, so people are desperately trying to exchange it to better stores of value.

Is Bitcoin valuable? It has no industrial or decorative uses, and it doesn’t entitle the holder to receive interest. It was intended to be valuable as a currency that is accepted the world over, but that doesn’t seem to be happening. The only major value that Bitcoin has now is its exchange value. Many people are willing to pay a lot of money today to get hold of some Bitcoin.

But what they are getting for their money is simply the hope that another buyer down the line will pay even more money for the coins. Once the music stops, there is no fundamental value to prevent the coins’ price from falling close to zero, save for their tenuous position as the currency of choice in the online drug trade and grey-area gambling.

Beanie Babies lessons

The idea that Bitcoin is valuable because it’s a store of value is upside down. In reality, something becomes a store of value because it’s valuable. In the 1990s, people started to trade Beanie Babies on eBay. Prices of these limited-edition plush toys rose to thousands of dollars, and by 1997 they made up 6.6% of the entire site’s transaction volume.

Some people invested their life savings into Beanie Babies, fully expecting their value to be preserved and more. But eventually people came to their senses and the market bombed. Beanie Babies are useful as toys and collectables, but that doesn’t justify thousand-dollar valuations.

The ConversationMy advice to individuals and institutions tempted by the headlines is to keep their savings away from Bitcoin and other cryptocurrencies and “initial coin offerings” (ICOs). I know serious blockchain developers won’t mind me saying this, because they see speculative bubbles and bursts as a distraction. For Bitcoin to truly function as a store of value, it first has to gain acceptance as a currency.

Vili Lehdonvirta, Associate Professor and Senior Research Fellow, Oxford Internet Institute, University of Oxford

This article was originally published on The Conversation. Read the original article.

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